Pensions Tax Relief Reducing the Annual Allowance DB WORKSHOP NB this document is intended purely to facilitate discus

1. Pensions Tax ReliefReducing the Annual AllowanceDB WORKSHOPNB this document is intended purely to facilitate discussion and is not a statement of Government policy 16th July 2010

2. 2 16th July 2010 AGENDA Introductions 5 mins Background and context HMT presentation – 5 mins DB valuation methodology for a reduced AA HMT presentation – 5 mins Discussion – 45 mins DB pension scheme response to a reduced AA Presentation – 2 mins Discussion – 45 mins

3. Background and context

4. 4 16th July 2010 June Budget announced: Fiscal imperative to restrict pensions tax relief, from April 2011, and ensure that reforms raise no less revenue than scored for the FA10 measure Government believes that an alternative approach to that legislated for in FA10 might better meet its objectives Would involve reform of existing allowances, principally the annual allowance Provisional analysis suggests an annual allowance in the range of £30k-45k might deliver the necessary yield Recognise that various features of the existing annual allowance would need to be revised to ensure it operated fairly and effectively at a much lower level Want to engage with interested parties to determine best design of the regime Intend to take a power in summer Finance Bill to repeal the FA10 measure. Will repeal it once the Government has decided on the detail of its approach

5. 5 16th July 2010 Broad timeline Restriction of pensions tax relief will: take effect from 6 April 2011 be legislated at Finance Bill 2011 Intend to publish draft legislation in autumn 2010: to give certainty over the approach, and allow time for scrutiny of and consultation on the legislation Summer 2010 – period of informal consultation: July: discussions on key work-streams End July: issue statement of further policy detail August: follow-up discussions on policy questions From September: drafting of legislation

6. 6 16th July 2010 Other workshops running in parallel Public sector workshop – Wed 21 Jul As today, with public sector scheme representatives DC workshop – Mon 19 Jul How will individuals and employers respond? Might schemes use AA as a form of cap? Views on managing individuals with large one-off contributions in DC schemes. Information requirements workshop – Thu 22 Jul How to help individuals fulfil their obligations in relation to a reduced AA; what information might schemes need to report to individuals and HMRC Should the pension input period be as now, or the tax year? Informal consultation webpage: www.hm-treasury.gov.uk/consult_pensionsrelief.htm You should also be aware that we’re running some other workshops next week – one with public sector schemes, one with DC scheme representatives and one on information requirements. If you do want to get involved in any of those and haven’t seen the invites then do speak to me about that separately. Any quick questions?You should also be aware that we’re running some other workshops next week – one with public sector schemes, one with DC scheme representatives and one on information requirements. If you do want to get involved in any of those and haven’t seen the invites then do speak to me about that separately. Any quick questions?

7. 1. DB valuation methodology for a reduced annual allowance (AA)

8. 8 16th July 2010 DB Valuation - Introduction Previously consulted on method for calculating a ‘deemed contribution’ to DB schemes on which relief would be restricted for high income individuals Similarly, under a reduced AA, need method for ascertaining a ‘deemed contribution’ in respect of DB rights Still need to balance Fairness – ideally the deemed contribution reflects what would need to put into a DC pension to receive similar benefits Simplicity – method should minimise admin burdens and help individuals make informed decisions Previous consultation concluded that two-way scale of age related factors achieved right balance; some support for flat factors; very little for CETV Key question for this discussion: for implementation of a reduced AA, how does the balance of arguments between FFs and ARFs shift? Assumption: still no strong case for CETV – as before too open to discretion, and too obscure for individuals

9. 9 16th July 2010 Re-cap on Flat Factors vs 2-way ARFs

10. 10 16th July 2010 Differences between HIERC and a reduced AA 1. No income test > wider testing of members against AA Simplicity may be more important to keep admin burdens down Simplicity may help schemes ensure members don’t breach the AA 2. AA tax charge is a deterrent rather than primary means of restricting relief Purpose of HIERC was to restrict relief uniformly, so fairness of such a charge paramount Under a reduced AA, primary purpose of the tax charge on contributions above the AA would be to act as a deterrent to pension saving above this amount – precise calculation of charge less critical 3. AA acts as a ‘buffer’ Tax charge only applies on contributions that exceed AA everyone treated fairly below the limit > Case for flat factors? [Also these already in the system, and time to implementation short] BUT: Being able to save similar amounts through DB and DC pensions before tax charge applies still an important consideration 4. AA brings in scope for creating fairness through use of age-related allowances > Case for age-related allowances?

11. 11 16th July 2010 Age-related factors vs allowances

12. 12 16th July 2010 Issues with a flat factor approach No account taken of NPA Loophole for DB scheme accrual – schemes will offer smaller pension from earlier age rather than bigger pension from later age Avoidance risk, putting yield at risk To what extent employers likely to offer pension in this way as part of remuneration package? Any solutions? e.g., high flat factor? No means of capturing enhancements through early retirement Loophole for DB scheme accrual – big unfairness vis-à-vis DC Avoidance risk, putting yield at risk Any solutions? e.g., use ARFs, or CETV, in specified circumstances?

13. 13 16th July 2010 Issues with a flat factor approach Revaluation – should this be incorporated? What are the practicalities of including revaluation? What would be the best approach for Fairness between DB and DC schemes? Fairness between active and deferred members? What is the balance here between fairness and complexity?

14. 14 16th July 2010 Summary of key questions Agree that choice between FF and ARF? Not CETV Any other reasons why relative weighting between simplicity and fairness might shift under a reduced AA? Views on case for considering age related allowances to make system fairer? Can any of the unfairness or design flaws of FFs be easily addressed? E.g., early retirement enhancements in specified circumstances If flat factors, should revaluation be incorporated?

15. 15 16th July 2010

16. 16 16th July 2010 Keeping accrual within a scheme under the AA Expect schemes likely to want to do this: to avoid if possible any admin burdens associated with informing individuals or HMRC where there has been a breach of AA (depends on overall information requirements – for discussion next week); to protect employees as much as possible from a tax charge that members may query, creating additional burdens; to ease communications. Also desirable from point of view of: protecting individuals on low incomes (e.g., basic-rate taxpayers) from facing a charge; protecting individuals with large one-off spikes.

17. 17 16th July 2010 How might schemes do this? (1) Cap accrual - Re-design benefit to avoid AA being breached in any one year e.g., cap pensionable pay increases (2) Smooth accrual – Smooth benefit accrual so that any large one-off increase delivered over a number of years, never breaching the AA in that scheme in any one year. E.g., increase pensionable pay slowly over a number of years. Or introduce an overriding rule to limit accrual such that AA not exceeded and excess carried over? What if individual leaves before smoothing complete? (3) Replace excess accrual – Cap DB accrual up to AA, provide excess (not necessarily equivalent in value) as cash or some other alternative (4) Replace all accrual – Offer option of opting-out of DB scheme altogether and taking alternative of e.g., a cash allowance (some of which could be put into a DC plan) (5) Remove ‘spiky benefits’ – withdraw benefit elements that cause spikes e.g., early retirement terms, ill health service top-ups, top-ups at retirement based on a service qualifier or in the contingency of redundancy

18. 18 16th July 2010 Key questions How else might schemes respond and why? How prevalent are any of these approaches likely to be? What Government action would be required to facilitate any of these? To what extent could the DB valuation methodology affect how DB schemes might respond? Do participants have any means of gathering empirical evidence on these questions? (e.g., surveys of schemes and what actions they might take)